Equity compensation and bonuses are taxed as income like anything else, but the timing and mechanics differ enough from a regular paycheck that they consistently surprise people — usually either at withholding time or the following April.
Cash Bonuses
A bonus is ordinary income, full stop — there's no special "bonus tax rate" despite how it can feel. What's actually happening is that employers commonly withhold bonuses and other supplemental wages at a flat rate (commonly around 22% for amounts under $1 million) rather than your normal paycheck formula. This flat withholding can be higher or lower than your real marginal rate; either way, it's trued up when you file, exactly as covered in our Marginal vs. Effective Rate and W-4 Withholding articles.
RSUs (Restricted Stock Units): Taxed at Vesting
RSUs are taxed as ordinary income based on the fair market value of the shares on the date they vest — not the date they were granted, and not the date you eventually sell them. If 100 shares vest at $50 each, that's $5,000 of ordinary income added to your W-2 in that year, regardless of whether you sell the shares immediately or hold them. Many employers automatically sell a portion of vesting shares ("sell-to-cover") specifically to fund the withholding on this income.
After vesting, any further gain or loss from holding the shares is a separate capital gain or loss, measured from the vesting-date value — see our Long-Term Capital Gains article for how the holding period and rates work from that point forward.
Non-Qualified Stock Options (NSOs): Taxed at Exercise
NSOs are taxed as ordinary income on the spread — the difference between the fair market value at exercise and what you paid to exercise — in the year you exercise, whether or not you sell the shares. Exercising and holding NSOs means paying tax on paper gains you haven't actually realized in cash, a common trap for employees at companies whose stock later declines in value.
Incentive Stock Options (ISOs): A More Favorable, More Complex Path
ISOs offer no regular income tax at exercise at all — but the exercise spread is a preference item for the Alternative Minimum Tax, meaning it can still trigger a real tax bill under a separate calculation. See our dedicated AMT article for how that parallel system works. If you hold ISO shares at least 2 years from the grant date and 1 year from the exercise date, the eventual gain on sale can qualify for long-term capital gains treatment on the entire gain rather than being split into an ordinary-income component — a meaningfully better outcome than NSOs, but one that requires planning around both the AMT exposure and the holding period.
Quick Comparison
| Type | Taxed As Ordinary Income When... | Key Risk |
|---|---|---|
| Cash Bonus | Paid | Under- or over-withholding vs. actual rate |
| RSU | Vests | Tax due even if you don't sell |
| NSO | Exercised | Tax on paper gains before any sale |
| ISO | Generally not at exercise (AMT risk instead) | AMT bill despite no regular-tax event |
Common Mistakes
- Not adjusting withholding around a large vest or exercise. The default withholding on equity compensation frequently doesn't match your real marginal rate, especially for high earners — review your W-4 or make an estimated payment around large equity events.
- Forgetting the vesting-date value becomes your cost basis. When you eventually sell RSU shares, only the gain since vesting is a new capital gain; the vesting-date value was already taxed as ordinary income and isn't taxed again.
- Exercising ISOs without checking AMT exposure first. A large ISO exercise in a single year is one of the most common triggers for an unexpected AMT bill.
Employee Stock Purchase Plans (ESPPs)
An ESPP lets you buy company stock, often at a discount (commonly up to 15% below market price), through payroll deductions. The tax treatment depends on how long you hold the shares after purchase:
- Qualifying disposition (generally holding at least 2 years from the offering date and 1 year from the purchase date): only the discount portion is taxed as ordinary income; the rest of the gain is long-term capital gain.
- Disqualifying disposition (selling sooner): the entire discount, plus any additional gain up to the sale price, is generally taxed as ordinary income, with only gain beyond that treated as a capital gain — and it may be short-term.
Selling ESPP shares immediately upon purchase ("same-day sale") is common and simple, but it converts what could have been favorable long-term capital gains treatment into ordinary income on the discount — a deliberate tradeoff some people make for simplicity and immediate liquidity, and a real cost others don't realize they're paying.
One More FAQ
Does my employer withhold enough on RSU vests automatically? Often close, but not always exact — the flat supplemental withholding rate can under-withhold for employees in higher brackets, especially when a large vest pushes total annual income meaningfully higher than what the withholding formula assumed. Reviewing your withholding around large vesting events, as covered in our W-4 guide, is worth the ten minutes it takes.